There has been a lot of talk about the sub-prime loans and the mess it created. It is touted to be one of the worst financial debacles of Wall street in modern times and we still do not know if we are past it. But, how did we reach this stage and why were we caught sleeping?
What are sub-prime loans?
Sub-prime loans are offered to customers with shaky credit and lower income. Sub-prime loans offer customers loans with adjustable interest rates. They start with low interest rates, allowing the interest payments to start low. The sub-prime rates reset after a fixed period(depending on the terms in the lending contract), after which the interest rates for the loan shoot up, thus making the mortagage paymets unaffordable to the same people. Sub-prime loans are one of the mechanisms devised by banks to lure customers, who otherwise would not have been able to pay motagage payments at prime(think of it as fixed) rates.
But why did banks do this?
To be a part of the housing boom. Banks, like the people who took the loans, bet on the theory that the house prices would go up forever. They assumed that the customers can refinance the homes at the increased value and pay the loans off, once the house prices go up.
Unfortuantely, that bubble did not last long. And, when it burst, it brought with itself, a long line of delinquencies and foreclosures. This lead to the devaluation of the assets/securities that investment banks held.
Such deflation in the values of the securites held by the banks led to the fire-slae of Bear Stearns to JP Morgan Chase. This is just one casualty in the turmoil. You can read more about the fall of Bear Stearns and its CEO Jimmy Cayne here
But, are we around the corner yet? Even, the experts are not very sure. Lets wait and see, what the Wall Street has in its hat!!!